The Basics of Dealing with a Loan Default

Over the past few weeks, several readers have written in with questions related to defaulting on their loans. Some individuals were in a precarious situation and were wondering about the consequences of defaulting, while others had already defaulted on their loan and were wondering what the consequences were.

What’s default? First of all, a loan default simply means that you’ve not met your obligations when it comes to your agreement to repay a loan. This can be something as simple as just missing a payment or being late on a payment, or it can be an avoidance of all payments.

Usually, when you’re in default, the organization that you’re indebted to will begin to contact you to get their money. Initial contacts are usually quite painless – merely reminders to pay. As the default continues, however, companies tend to get more aggressive, contacting you repeatedly with stronger language.

Eventually, this will begin to affect your credit (usually when you’ve been in default for thirty days or more), which makes it harder for you to get other loans, can increase your insurance payments, and can even affect your ability to get a job (as many jobs now run a credit check before they hire people).

Eventually, a loan default results in repossession or foreclosure (if your debt has collateral) or having that debt turned over to a collection agency (if your debt doesn’t have collateral). The impact on your credit card worsens over time, but as you approach the seven year mark since your default, the impact of the default lessens on your credit history.

Obviously, if you’re recently in default, you’re better off acting now rather than later.

What should I do? As soon as you recognize you’re in default on a loan or about to be in default, contact your lender. Go over the situation in detail with them and see what your options are.

Most of the time, lenders would far rather work out a payment solution directly with the borrower than entering into a foreclosure situation. Quite often, foreclosures and repossessions and collection situations are the result of a lack of communication between the borrower and the lender. Your best bet is to be proactive.

What if I don’t have the money to pay? This is the reason that most people are afraid to be proactive about their debt situation. They simply don’t have the money to pay the debt, and they figure that contacting the lender won’t help, so instead they choose to stay put and hope things get better.

Here’s the problem with that approach: lenders will assume that you never have any intent to pay. They have no reason to believe otherwise, so they will lump you in with the rest of their debts and treat you in a standard fashion.

If you are making a genuine effort to repay your debts, sitting on your hands is not the best option. You are far more likely to get an easier payment schedule, a forbearance, or some other solution if you contact your lender and deal with the situation.

What if my debt is already in collections? If your debt has already been turned over to a collection agency, your best bet is to negotiate with the collection agency. Do this entirely in written form via registered mail with receipt requested, not over the phone, and keep thorough records of this process. Even if they call you, ignore the call and follow up with mail.

If your debt is already in collections, the bad news is that your credit has likely already been significantly damaged. The good news is, though, that you should be able to negotiate a conclusion that can somewhat reduce the damage for an amount much smaller than the face value of the debt. Here’s some excellent advice on how to negotiate in this situation.

In a nutshell: if your debt isn’t in default yet or is freshly in default, call your lender and see if you can come up with a better payment solution. If your debt has been turned over to collections, communicate only in written form, keep your records carefully, and negotiate using these tactics.

Enjoyed reading this post! My brother refers to the sitting on your hands, hoping things will get better as “using hope as a method.” This is never a good idea. We all need hope, but taking action steps, making positive choices, and dealing with challenges head on will give us more confidence and hope than “using hope as a method” and attempting to just wait out the storm.

Good Post! However I can’t say I agree with the ideas on the links to the Credit Infocenter. I guess I am old school, and still believe if you created the debt you need to pay for it. I understand that sometimes default can’t be avoided, for instance in the case of an illness. But if you are able to work in some capasity even if it is not at your usual skill level, working to pay your own debt is the best option in my book, even if it means a second job.

Good advice. Another very useful thing to know if you’re in this situation is that you can tell collection agents to stop calling you at work or home and they have to stop calling per the Fair Debt Collection Practices Act. Having them call and harrass you when you’re already doing your best to take care of your debt is just stressful and not productive.

Just want to emphasize something mentioned on the strategy page you linked to–MAKE SURE THE DEBT IS WITHIN THE STATUTE OF LIMITATIONS BEFORE MAKING ANY PAYMENTS OR AGREEMENTS TO PAY ON IT. There are unscrupulous collections agencies out there who will dig up “zombie debts” that are legally uncollectable and attempt to collect on them. (I believe this is itself illegal, but there’s no industry scummier than collections.) The statute of limitations can be as short as three years sometimes. Since the damage to your credit report is already done at that point, there is no reason to pay such a debt.

I have not felt compelled to comment here until now. I understand that everyone is entitled to hold their own set of values, but that does not mean that there is no subset of universal values that can be accepted by all fair minded people. I believe that Integrity and Honesty are two of those values. The suggestion that people should avoid paying for a product or service that they consumed simply because the Law gives them that legal right is shocking to me as well as saddening. A person in that situation who values Integrity would seek to do the right thing (as defined by that universal set of values) even if doing the right thing would stall progress on their other goals. A person in that situation who values Honesty would seek to keep their promise to the credit company, which they made at the time of purchase, as long as it was in their power to keep doing so. Can we at least agree on Integrity and Honesty? If so, then I would be very interested in a generally applicable argument based on those two values that justifies your original advice. Peace.

I would second Sarah, collection agencies are scum, who think nothing of bending and breaking the law to take advange of peoples ignorance. know your rights and obilgations, the internet is wonderful resouse for that.

Sarah says: “Since the damage to your credit report is already done at that point, there is no reason to pay such a debt,” and Rob agrees.

NO reason? Is protecting your credit score the ONLY reason to keep a promise? How about BECAUSE YOU PROMISED!

Is the only reason not to shoplift at the store, or steal from your neighbor, or cheat your customer, that you might get arrested?

Maybe collection agencies are scummy because they are constantly dealing with scum.

The statute of limitations is an affirmative defense. It doesn’t render a debt void or its collection illegal. It just renders it legally unenforceable. It is still a debt, and moral people do have reasons other than credit scores to pay their debts.

A person who feels no moral obligation to keep promises and repay debts is certainly in no moral position to complain about collection agencies bending rules or taking advantage of people’s ignorance.

Not every person who can’t pay a debt is scum, but all scum who won’t pay their debts are going to end up on a collection agency’s calling list, and they fully deserve to be there.

In times like these, when foreclosures are happening at an alarming rate, if you’re defaulting on your home loan because you can’t pay, get in contact with your lender. More than likely they’re going to be willing to work through your situation with you, rather than kicking you out of your home, because in that situation no one really wins.

About your comment about people’s moral positions. I agree that it is a hypocritical position to take, but we are all hypocrites to one degree or another. And quite frankly some of those companies do break the law and work outside the law and try to badger / threaten people to pay debts they don’t owe.

This happened to myself. While in the military, I was in the hospital and was transferred by ambulance to a military hospital once my condition had stabilized. Since I was in the military, the government picked up all the expenses. Imagine my surprise when a collection agency contacted me several years later looking for many hundreds of dollars for the ambulance ride. I politely explained that I was in the military at the time and they should contact the US Government. They were not interested in that and continued to harass me and everyone around me. I forced them to follow the law by sending them a registered letter asking them to not contact me anymore and to send a copy of the receipt (per federal law.) They never responded with a copy of a receipt, but it didn’t stop them from calling my parents phone number several times a week for the next year. This company had several lawsuits filed against them by different state District Attorneys. I have yet to be able to fully clean up my credit report.

I think people have an obligation to pay to the best of your ability but if unforseen things happen in your life and you can’t pay I wouldn’t blow it out of proportion and let it impact my life. All companies have bad debt provisions which in the past have worked – well before the mess of CDO’s hit the world anyway.

AnnJo, why don’t you look up what a statute of limitations is before blowing a stack of self-righteousness?

We as a society have established laws governing debts. If a company wants to collect an unpaid debt, it has several years to bring an action against you to do so (and the time period can be extended under various justifications). This is not a secret. This is not something unknown to them. In fact, you can be sure that if they are in the situation of owing a debt themselves that is uncollectable, they will assert that defense. There are very good reasons for statutes of limitations.

If you don’t see the difference between refusing to pay a debt that is legally uncollectable and breaking the law and trying to intimidate people who don’t have to pay into giving you money, I don’t know what to tell you, except enjoy rolling over for every scumbag who turns up on your doorstep.

Sarah, you are talking law and I am talking ethics. They are not the same thing.

I know perfectly well what the statute of limitations is, at least for the two states where I am admitted to practice law. And I also know it is ethically neutral in its application. The cynical deadbeat who borrowed her life savings from his impoverished granny and the innocent victim of a collection agency gone wild may both use it with equal legal effect.

I’m talking about whether a moral person SHOULD use it to evade a legitimate debt that he or she can afford to pay. That was your recommendation, wasn’t it? You did say there was “no reason” to pay your debts if the damage to your credit score has already been done?

Some people believe that their moral duties require only that, in skating as near to the edge of illegality as may be convenient to them, they do not cross the line. Others don’t much care where the line is. You may be such a person, or maybe you just wrote without giving the subject much thought. I wrote to encourage others to give your recommendations more thought.

You rightly criticize collection companies for behaving in an immoral way, yet you encourage people to adopt that same standard in dealing with their own debts. That is my objection to your earlier comment.

Ken and Bill in NC both offer examples of instances where any legal defense including the statute of limitations can morally be asserted, because there is no moral obligation to pay a debt that was never incurred or the existence of which is unknown and cannot be determined.

Ken, yes, it is true none of us live up to our highest moral aspirations and in that sense, we are all hypocrites. Too many people use that reality to abandon moral aspirations altogether. I don’t think that as individuals or as a society we can afford to encourage that, as I felt Sarah was doing. Thank you for your service. I hope your physical recovery at least is complete and that your credit problem gets resolved soon.

Ken in NC, if there is any doubt about the validity of a debt (as there clearly was in your case), by all means force the creditor to prove it. But if one knows it is a legitimate debt then the only reason for the “proof” exercise is if one intends to evade one’s debt if possible. Legally, that’s a right. I’m suggesting that the morality of that should also be considered.

A senior banker friend told me once that they would prefer a borrower in default to come up with a scheme (in fact, almost any scheme) rather than one who just surrenders, anyday.

I went through one such case a few years back. We kept the bank officers informed regularly on exactly why we were behind. The officers were very supportive and we went through the difficult year together without any serious penalty.

Here is my dilemma. I am a single mom who is not receiving even now after 1 1/2 years of fighting in court with the father, a 1/3 of the child support that I am supposed to be getting. He doesn’t have a job and gets paid cash somewhere. I now have with legal fees and daycare and overall needs for my son and owning a home over $30,000.00 in credit card debt. I am thinking about trying to settle because there is no way that I can pay this and I have gone through my 401(K), savings, etc. trying to do so. So now I’m out of resources. I have a good job and am trying to work a part-time job, based on referrals and still spend time with my son. Advice?

If you want to talk about the moral point of view – there is nothing moral in usery in the first place. In fact, there isn’t anything moral in capitalism. The concept that one owns anything at all is immoral. Ownership was created by greedy people. Lending was created by greedy people who wish to live on the backs of others. The whole system stinks and there is not question in my mind that lenders take advantage of people. The more they lend, the more need there is to borrow just to keep up. Fiat currency is immoral. The whole system is based on immoral actions by smart, conniving, greedy people taken against less smart, less conniving people. I think someone needs to hit the reset button about now. Looks like the system will do the button pushing.

Capitalism provides for people to enter into voluntary transactions with one another, where each side is better off = according to his or her own judgment – for the other side having been available to do the transaction. If I’m starving because my crops failed, and you have food and offer to feed me in exchange for every last nickel I have, the deal sucks for me, but the only compulsion I am under is that of my circumstances, and I am better off accepting your deal than if you hadn’t existed to make it.

The other alternative would be for me to steal your food or shoot you to get it (or delegate the task of stealing to the government, as in social democracy, socialism or communism). The problem with that as a social solution is that the more effectively it is done, the more it results in a Zimbabwean situation. You may successfully steal my food this time, but why would I grow any more next year if it too will be stolen? Sooner or later, only force will keep people producing, and then not very well.

Capitalism allows one person to gain a benefit from another’s needs (the farmer benefits from the consumer’s hunger, the doctor from the patient’s sickness, the plumber from the homeowner’s broken pipe) BY SATISFYING THE NEEDS. Both sides are better off after the transaction, at least in their own judgment, or they wouldn’t do the deal. It may sometimes be harsh, but I find it moral as long as neither side is compelling the other’s participation.

Making the farmer, doctor and plumber slaves of those who need their services avoids the “greed” problem you describe, but most people do not regard slavery as moral.

“Ownership was created by greedy people.” Hard to say, since it was created so far back in human history. More likely ownership was created by the desire of people to keep the products of their own labor. Which is more “greedy”? For me to want to be paid interest if I lend you the money I saved from my hard work and frugal living, or for you to want to use that money without paying me interest?

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